When should I switch my very aggressive asset allocation to a moderate one?
In my 403(b), I've accumulated $150K (still contributing) and have an all-equity fund allocation. I'm currently 47 yrs old and thinking of changing my allocation to a moderate one 10 years from retirement and then to a conservative one in retirement. Is that a sound plan or too risky of one?
The general rule is that you should match your assets to your investment time horizon. In your case, if you plan to retire at 65 you are 18 years away from needing to take any money from your 403(b) (or the rollover IRA you will create between now and then). If you have savings that are sufficient to live on between retirement and age 70-1/2 (when you HAVE to start taking money every year) then your retirement investments can grow untouched for over 23 years. Then, you will only be taking a small amount each year for the rest of your life. So some of your savings is earmarked for each year of your life from 70 on up. This makes you a long term investor.
A long term investor should own equities and not be fearful of short term risk. If you put money into conservative assets (bonds, say) you are accepting a lower return in exchange for less fluctuation in value. If fluctiation does not affect you because you are over 20 years away from needing the money, then accepting a lower return is dumb. I call it the "risk of safety" and over time the cost could be very large. I know there are formulas out there that tell you to have X percent of your money in bonds at such-and-such an age; but that's a snare and a delusion. Not everyone your age has the same ability to take risk as you do.
After you retire I recommend that you keep about 2-3 years of living expenses, plus something for emergencies, in something low-volatility and hold the rest in high-quality stocks. For now, 100% equities is the best choice. Invest in high-quality companies and don't worry.
I think you have the right mindset. Here's a little more details to add precision to your plan.
Your investment plan should match your investment time horizon. The shorter the amount of time until you need a certain amount of money, that money should be invested conservatively. Since you will not need your retirement funds for another 10 years, an all-equity or a growth portfolio should be fine.
Once you are getting closer to retirement, find out how much income you will need from your assets. For example, let's say you need $4000/month in income and have passive income (pension income, social security, rental income,...) of $3000/month, then you will need $1000/m (or $12,000/y) from your assets to supplement your retirement income need. Here's how you would then allocate your portfolio.
1. Cash: $12,000 (Money you will need within the next year should be allocated in cash to rid of any fluctuation)
2. Conservative allocation: $24,000 (Money you will need in year 2 and 3 should be conservatively allocated)
3. Moderate allocation: $48,000 (Money you will need in year 4, 5, 6 and 7 should be allocated in a moderate portfolio)
4. Growth allocation : rest (The rest should allocated in a growth portfolio)
Every year, you should move money from number 4 to 3, 3 to 2, and 2 to 1. This method should help you lower short-term volatility with money you will soon need and still give you the ability to grow your assets for future income need.
I hope this helps.
Let me respond to your question by sharing a blog post I just put up.
Re-Stating the Obvious
Forgive me for stating the obvious but in my experience, it is precisely those things that are most important to restate. People need to hear what is obvious…until they finally get it.
One obvious point is that keeping physically active and mentally engaged preserves one’s health and saves money. Obvious? Sure. Yet people don’t follow this advice, though they are far more apt to do so when they internalize what the cost of health care is. The average person spends $275,000 on health care expenses in retirement. So an investment in good health can play a huge role in making one’s retirement numbers work out.
A second “obvious” is the benefit of setting up multiple streams of income. If you have income from multiple sources that don’t fluctuate because of moves in the market your retirement is much safer than if you are totally dependent on your portfolio to support you. What are those income sources? Social Security is one source for almost everybody. So are pensions. Another source can be annuities. If you can get two, three or even more paychecks every month you worry less about the market going up or down.
Third, saving 15% of your pay, applying the 4% rule and steering clear of the “retirement risk zone” that spans the five to ten years before and after retirement makes so much sense that it’s obvious. But how many people actually follow this obvious advice?
Finally, having a plan prepared by a competent advisor who specializes in retirement planning is an obvious way of tying these points together. A plan can take the cost of health care into account and see how the risk of a serious illness can be mitigated. It can define the income streams you need in order to meet your basic needs and your “wish list.” And it can determine the amount of risk you are taking to meet your retirement goals and warn you about taking too much risk.
Assuming that you are in good health, you still have a long time horizon. With at least 20 years to go, an all-equity asset allocation is appropriate since it is most likely that equities will provide the highest returns over spans of 20 years or longer. As the spans shorten, it would be a good idea to introduce fixed income and alternative investments to your portfolio. In the fixed income class, you might want to consider exchange-traded funds that hold high yield bonds with maturities of five years or less. In addition, you may want to consider closed-end bond funds when the discounts from net asset value are 5% or more. Among the alternatives, worthwhile opportunities exist in exchange-traded funds that use buy-write (covered call), put-write (covered put), and long-short strategies. By adding these kinds of holdings, you will introduce shock absorbers that will dampen interim market price fluctuations that will take place along the way.
Bottom line: I think your plan is sound and have offered some suggestions for implementing same.
Dear Planning Ahead,
You're doing a good job of thinking through your accumulation and distritbution years. Your risk "capacity" is large as long as you have 10 years+ until retirement. So despite the likelihood of a market "correction/adjustment/crash" - whatever the word of the day is - during the next two years, you've got enough time to come back. And the good news? When you're not trying to "time the market" but instead "time your life," you get to stay in the market for all of the gains.
So your plan isn't risky, it's sensible. No one can predict what is going to happen in the market but you can predict/plan how you want to experience your life. If you are retiring at age 67 - your full retirement age when you are eligible for full benefits from Social Security - you've got 20 years until you will start spending your savings. Even then, you can continue your good stewardship by planning how much you will spend based on what SSA.GOV says you will receive in benefits. Plan ahead for ages 67 to 77 and the rest of your savings can fall back into your age 47 risk capacity (because it will be 10 years before you need to spend any of it).
I hope that makes sense.